ABCP investor asks Prentice to reverse change in federal law
Published Tuesday October 28th, 2008

Kristine Owram, THE CANADIAN PRESS

TORONTO - A retail investor who bought asset-backed commercial paper before it became a four-letter word is asking the federal government to reverse a Cabinet decision that she says has unnecessarily delayed a proposed restructuring of $32 billion worth of third-party ABCP.

Wynne Miles says that an amendment to the Companies' Creditors Arrangement Act, approved last November by the federal cabinet, appears to give special treatment to international banks over individual investors involved in the ABCP restructuring.

Efforts to rescue the third-party ABCP - a form of debt that had been considered by many investors as a low-risk way to earn interest for a few months at a time - began soon after the market suddenly froze in August 2007.

However, a plan to unfreeze the assets and salvage at least some of the investors' money has been delayed by numerous court challenges by different types of creditor.

The deal has received court and creditor approval but the restructuring has been stalled - it's now to be completed by November - as lawyers for various parties review the agreements.

Miles argues that the change in CCAA rules, signed by Industry Minister Jim Prentice, has been a "major factor in the delay" because it limited the judge's ability to treat international banks equal to other parties and his ability to set firm deadlines.

"I feel this order in council needs to be reversed so that all parties would be on an equal playing field," Miles said in an interview Tuesday, after writing a letter to Prentice.

But Industry Canada replied in a letter obtained by The Canadian Press that the process was the fairest the government could devise.

"In considering stakeholder comments received during the regulatory process, the government strived for a solution which was most consistent with its underlying policy objectives and fairest to the collective interest of all stakeholders," the letter reads.

Investors haven't been able to redeem their investments in ABCP for more than a year, and the repeatedly delayed restructuring now isn't expected to be completed until the end of November.

The Pan-Canadian Investors Committee, which was set up by large-scale investors to salvage the ABCP, says the process has taken longer than expected because of the large number of participants, the complexity of the documentation and the recent volatility in the global financial markets.

Asset-backed commercial paper was supposed to be a low-risk, short-term investment that would mature within a year. The restructuring calls for holders of the notes, also called non-bank ABCP, to swap them for new notes that will mature in several years.

An estimated 99 per cent of the notes are held by institutional investors, such as pensions and businesses, but $371 million is held in 2,542 retail accounts.

Most of the retail investors with less than $1 million in ABCP will be compensated in separate side deals with their brokers - but only once the main restructuring is completed.

The Pan-Canadian committee was set up by a number of institutions with major ABCP holdings after the market for Canadian third-party asset-backed commercial paper dried up in August 2007.

The process has required court-supervised approvals from noteholders. While the deal was passed by the required majorities in April, some creditors objected and launched court challenges.

In September, the Supreme Court of Canada declined to hear an appeal of requests by the unhappy noteholders, ending the litigation delays.

But the broader credit market has also undergone tremendous upheaval in recent weeks - including government interventions and bank bailouts in the United States, Europe and elsewhere.

Diane Urquhart, an adviser to a number of retail investors with ABCP, said Tuesday her clients are beginning to "panic."

"These people aren't sleeping, they haven't been for months," Urquhart said in an interview. "It's a little bit like Chinese water torture.".

Urquhart said some of her clients are beginning to worry that the deal is falling apart because it's now in the hands of the international banks - and that's why the cabinet's decision is so worrisome.

"This provision, whether it was a mistake or not, was clearly for the benefit of the international banks and Canadian banks operating in the credit default swap markets," she said, adding that it's time the government steps up to help the individual investor.

The events over the past couple of weeks lead to one conclusion: When it comes to banks, the dominant force in the Canadian financial scene, the government is prepared to look forward but not to try to right any wrongs.

The latest example played out yesterday when Ottawa unveiled a plan to backstop the banks. That plan is "a temporary insurance program" known as the Canadian Lenders Assurance Facility. "This will be a backstop that will be available in case conditions in the global credit markets disrupt Canadian lenders' access to the funds they need to keep lending," said Jim Flaherty, the Finance Minister.

Sounds fine -- even if the same government was telling us a few weeks back that Canadian banks were the envy of the world. Indeed, we were told we had the best banking system in the world. Since those statements, the government -- through CMHC -- has agreed to a plan to buy up $25-billion of NHA-insured mortgages from the banks. At the time, Ottawa said the move was aimed at maintaining the availability of long-term credit, which is under severe strain as banks are reluctant to lend to each other. "It is becoming increasingly clear that the continuing disruption of global credit markets, which has been severe and protracted, is making it difficult for our financial institutions to raise long-term funding," Flaherty said.

Fair enough, we all benefit from a sound financial system (I thought we already had one), but the bailout for the banks has to be juxtaposed against the treatment meted out to those holders of asset-backed commercial paper -- a made-in-Canada problem that affected $34-billion of assets. This week the much-delayed restructuring and payment to some of the unfortunate investors who bought that stuff was delayed again because of the financial crisis. That workout has been underway for more than 14 month and the agreement included a clause that didn't allow any litigation by affected parties.

Given the stated reasons for delaying the plan, there can be no guarantees that the restructuring will be wrapped up by the new date, the end of next month. That news has to be seen alongside the 113-page report released last Friday by the Investment Industry Regulatory Organization of Canada. One key conclusion:

"... the majority of dealer members that acted in the distribution of third-party ABCP to retail investors did not understand the underlying asset composition, liquidity risks and distinct rating methodology used for the structured financial assets underlying the ABCP. Instead, they relied on the product classification as a money market instrument, the securities distribution exemption and credit rating."

In other words, the dealers, including the bank-owned dealers, foisted a product onto investors that they didn't understand, hadn't researched -- but from which they got a fee. Earlier the OSFI, the federal regulator, said it was nothing to do with us.

The double standard hasn't gone unnoticed. Wynne Miles, one of the leaders of the Facebook group, has written to Bank of Canada governor Mark Carney saying,

"The Canadian banks need to take responsibility for the sale of these faulty products and take care of their customers. I do not think the Canadian banks should receive any more federal money until they do so." Miles said yesterday that "confidence in the banks can't be created unless you take care of your existing customers."

Everything you ever wanted to know about the biggest economic meltdown since the Depression, but were afraid to ask.

From 1982 to 2000, the U.S. stock market went on the longest bull run ever, as share prices rose to dizzying heights. In the late 1990s, a combination of factors, which included the Federal Reserve lowering interest rates, created a huge price bubble in Internet stocks.

A speculative bubble occurs when price far outstrips the fundamental worth of the asset. Bubbles have occurred in everything from real estate, stocks and railroads to tulips, beanie babies and comic books. As with all bubbles, it took more and more money to make a return*. This led to the Internet bubble popping in March 2000.

During this market mania, the Fed gutted the Glass-Steagall Act, enacted during the Depression to prevent the type of banking activity that led to the 1929 stock market crash.

In 1996, the Fed allowed regular banks to become heavily involved in investment banking, which opens the door to conflicts of interest in banks pushing sketchy financial products on customers who poorly understood the risks. [like ABCP in Canada]

In 1999, under intense pressure from financial firms, Congress overturned Glass-Steagall, allowing banks to engage in any sort of activity from underwriting insurance to investment banking to commercial banking (such as holding deposits).

*For instance, if you purchased 100 shares of Apple at $10 a share and it rose to $20, it cost $1,000 to make $1,000 profit (a 100 percent return), but if the shares were $100 each and rose to $110, it would cost $10,000 to make $1,000 profit (a 10 percent return -- and the loss potential would be much greater, too.

Many Americans joined the stock mania literally in the last days and lost considerable wealth, and some, such as Enron employees, lost their life savings. When the stock market bubble erupted, turbulence rippled through the larger economy, causing investment and corporate spending to sink and unemployment to rise.

Then came the Sept. 11, 2001, attacks, generating a shock wave of fear and a drop in consumer spending. Burned by the stock market, many people shifted to real estate as a more secure way to build wealth.

By 2002, with the economy already limping along, former Federal Reserve Chairman Alan Greenspan and the Fed slashed interest rates to historic lows of near 1 percent to avoid a severe economic downturn. Low interest rates make borrowed money cheap for everyone from homebuyers to banks. This ocean of credit was one factor that led to a major shift in the home-lending industry -- from originate to own to originate to distribute. Low interest rates also meant that homebuyers could take on larger mortgages, which supported rising prices.

In the originate-to-own model, the mortgage lender -- a bank, private mortgage company or credit union -- holds the mortgage to term, usually 30 years. Every month the bank originating the mortgage receives a payment -principal and interest - from the homeowner.

If the buyer defaults on the mortgage, the bank can seize and sell the house. Given strict borrowing standards and the long life of the loan, it's like the homebuyer is getting married to the bank.

In the originate-to-distribute model, banks sell the mortgage to third parties, turning the loans into a commodity like widgets on a conveyor belt. By selling the loan, the bank frees up its capital so it can turn around and finance a new mortgage. Thus, the banks have an incentive to distribute mortgages fast so they can recoup the funds plus fees and interest (no 30 year wait) and sell more mortgages. By selling the loan, the bank also distributes the risk of default. In effect they loan someone else's money - an investor's.

Because in the last decade they have sold the loan, in just a few days, they had no concern that a buyer might default. It was not their money at stake. They began using high-pressure tactics to mass-produce mortgages [and credit cards, car loans, lines of credit, business loans, etc] because the profit was in volume--how many loans could be approved how fast. This was complemented by alleged fraud throughout the real estate industry, credit card and car loan industries - and some banks. Appraisers over-valued homes and mortgage brokers approved anyone with a pulse, gave out credit card and car loans in the same way - not verifying assets, job status or income.

Rating agencies did the rest. Credit bundles that would never return principle plus interest were rated Triple A. Any federal agency involvement was seen as an implicit guarantee: While there was no explicit guarantee, all parties believed bundled loans were solid or kept their mouth shut!

This allowed people to borrow huge sums of money at low rates. Average people were allowed to (encouraged to) swamp themselves in debt. In Canada, there was another sweetener, having helped create the problem, banks were allowed to simply walk away - no wonder they are still strong.

Banks sold their new mortgages and other loans to "bundlers", such as investment banks, hedge funds, etc. Bundlers pooled many types of credit of different quality with the intention of selling the payment rights to others, first to other institutions - pension funds, companies, governments, etc.) so someone paid to get your monthly payments - if you paid. They paid for nothing if you defaulted!

The next step was to securitize the bundle as a tradable asset. Much of the financial black magic of Wall Street/Bay Street and the Rating Agencies involved turning debt into assets.

Say you're a Bank and you sell 200 mortgages a day, give out 500 low-interest credit cards, 50 lines of credit, and 100 car loans. Bundlers bought those and sliced and diced them into an asset-backed security (MBS).

This, like ABCP in Canada, is a financial product that was supposed to pay a yield to the purchaser, such as a hedge fund, pension fund, investment bank, central bank and finally private investors.

The yield, essentially an interest payment, was to come from the payments made on the original loan....if they were made...sadly, the ABCP/MDS were sold to mature within days; the loans on which they were based were for years and to many people who never had a hope in hell of being able to pay --- especially if interest rates rose.

How does it work? The borrower is supposed to keep making payments which makes money for everyone down stream - fees from the original deal, an outfit that gets a cut for servicing the payments and passing them on to the bundlers and the underwriters of the asset-backed security that results and is sold by them to their clients.

The purchaser of the asset-backed security is supposed to get paid directly by whomever sold them the bundle or part of it as a secure (or appropriately rated) investment. If anything goes wrong, the originator may take a hit. In Canada, banks and their accomplices play Pontius Pilot and take a powder.

To the extent that they can't, they give the worthless debt to the bank of Canada and get "Cash for Trash". If it does get stuck in the bank, the accounting profession changed the rules - even though it is worthless because nobody anywhere will now buy these bundles, instead of the bank stating on it books that it has toxic assets, it can estimate what they think this stuff might be worth if things were normal, and plug this imaginary number into its financial statements.

If I could do that, my 02 Maxima would be worth $1,000,000.00 - hey, it's a great car! I'm rich. And I can borrow another million or ten using the Maxi as collateral!

Easy credit fed investors' appetites (fueled in turn by mass marketing campaigns) for more and more credit - not just for mortgages - as most people seem to forget.

Many loans were adjustable-rate with teaser rates to start - credit cards at 1 or 2% that automatically flipped to the regular rate after 364 days, for example. Miss that deadline, and your debt load and monthly payment might give you heart failure!!!

Even fixed rate mortgages are usually only for 5-10 years --- then???? Result, at some point - sooner or later - monthly payments leap sometimes to two or three times the original amount. But demand for everything increased, and that caused housing bubbles and stock bubbles all over the place. People overpaid and if they were caught short or will be, it will be a slaughter.

Bill paying became hard to impossible for many almost immediately, making it more likely that payments would be late or missed, driving down credit ratings and adding charges to the borrower's debt load. Much of that is sunk money - it will never be collected. Principle and interest to those who bought it bundled may never be paid, at least in full. Others may not see this happen to them for some time, but the years go by so quickly....

With mortgage brokers and lenders pushing loans on anyone and everyone, even those who knew better could often not resist the temptation. And, the elderly -- who fell for re-financing their homes - and others in debt - found or soon will find, themselves in over their heads.

Some got it from both ends - as they or their Pension Plans or CPP, bought worthless bundles, they lost there too....they lost coming and going - and some - pensioners, taxpayers and others still don't even realize the peril they face. When the government intervenes, it's YOUR money!

Even if they do get a pension that is not reduced or eliminated, it will be in dollars of lesser value or taxpayers money - you will be paying your own pension - a second time - because the government has increased the money supply - increasing inflation and reducing the value of the dollar against other currencies.

With the surge in mortgage loans, especially around 2004, US financiers started using financial products called collateralized debt obligations (CDOs)....and several other alphabet soup names...that are still around. These were bundles sliced and diced into tranches -- cuts of meat -- in the US that paid a yield according to risk: the best cuts, the filet mignon, had the lowest risk and hence paid the lowest interest. The riskiest, the mystery-meat hotdogs, paid the highest interest, but could default first if people stopped making payments.

This was seen as a way to spread risk - away from the banks - across the market (to you and me). The notion of distributing risk means all market players [even those who don't think they are in the market] take some risk, so if something goes wrong, everyone suffers, but no one is supposed to die.

Tranches were given ratings by agencies like Standard & Poor's, Moody's and Fitch --- none of them would touch Canadian ABCP with a ten foot pole --- but DBRS gave it a Triple A rating anyway.

The highest rating, AAA, is supposed to mean there was virtually no risk of default. The supposed safety of AAA corporate paper meant a wide variety of financial institutions could buy it. And this spurred demand.

There was a conflict of interest, however, because the rating services earned huge fees from the bundlers (investment banks). Moody's earned nearly $850 million from structured finance products in 2006 alone. We'll likely never know the whole story in Canada. You can thank the Purdy Crawford Committee, the Finance Minister, the Regulators, the Bank of Canada and the government of the day for that - and you just re-elected them???

The 'Piggies in the middle" also bundled lower-rated securities, BBB-rated, and then created new tranches -from AAA to Junk. In Canada, we skipped a step and just rated junk AAA from the get go - turning the hotdogs into steaks, lead into gold - until it hit the fan last August.

Furthermore, the tranches could be hedged and leveraged, another way of distributing risk, using paper called credit default swaps (CDSs) or similar names, sold by near banks, investments houses or whatever you want to call them. I have a name - but I don't want to be sued.

The swaps were seen as a way to make tranches more secure and hence higher rated. For instance, say a US investor, pension fund, etc (I know of one elderly Canadian woman who had $20 million in ABCP) had $10 million in AAA tranches. You/they might find someone to insure it - the premium based on the rating. If the tranche defaulted, the company was supposed to pay $10 million in the US.

But CDSs started being brought and sold all over the world - based on advertised low risk. The market grew so large that the underlying debt insured in the US was $45 trillion -- nearly the same size as the annual global economy! Tell me that does not defy common sense!
Around 2004, things began to get trickier when investment banks set up structured investment vehicles (SIVs). The SIVs would purchase poorly rated subprime mortgages from banks. But to purchase them, the structured investment vehicles needed funds of their own. So the SIVs created asset-backed commercial paper (short-term debt of 1 to 90 days) backed by credit from the sponsoring bank in the US - in Canada - by NOBODY.

The SIVs then sold the paper, mainly to money market (institutional - and mutual) funds. So the SIVs generated money to buy MORE mortgage-backed securities from their banks. They made money by getting high yields (returns/profits) from the subprime MBSs, while paying out low yields (interest/returns) to whomever bought this stuff as commercial paper (profiting from a spread like this is known as arbitrage).

Confused yet? Believe me - you were and are meant to be.

Wall Street's/Bay Street's goal was to create ways to make money while not incurring liability....they had seen the Canadian Banks do it. They started moving everything off-book to the SIVs to get around rules about leveraging.

In Canada there are no rules - rules that exist are not enforced - same difference. We then have the nerve to call every problem we have had US-based. We have been the testing ground for every scam that has played out in my lifetime.

Banks, hedge funds and others "leverage" by taking their capital reserves and other assets -- cash or assets that can be easily turned into cash -- and borrowing over and over against them - using the original assets as collateral. Every dollar can make you at least ten as long as the game goes on; but if someone yells "Wait just a minute!", the reverse is true. And you can't pay. You're done.

Now in Vegas, you get you legs broken (if you're lucky) for that kind of stuff; in the US, you go broke and the top dogs can go to jail; in Canada, nothing. Here, the last person or organization holding the junk, for the most part, takes the hit and the Banks walk away whistling.

At worst, they bring in some body like Purdy and the boys and tell you, you won't see your money for a decade, if at all. Then they launch a PR campaign to cover up the truth - and it works!

In the US, Merrill Lynch had a leverage ratio of 45.8 on Sept. 26. That means if they had $10 billion in hand, they were playing around with $458 billion.

The Federal Reserve is supposed to regulate reserves to limit credit, but the SIVs were a way to get around that rule. More leverage meant more risk because that $458 could disappear in a flash if the music stopped.

This is part of what Americans call the Shadow Banking System, meaning it gets around regulations.

In Canada, it's just the way it is. Don't take my word for it - take a look around.

It was deregulation (self-regulation in Canada) that led to the huge growth of the shadow(y) banking system.

In 2004, Wall Street lobbied the SEC to loosen regulations on how much they could leverage their reserves. This opened the flood gates "to the opaque world of asset-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments," according to the New York Times.

The only oversight left in place was self-policing by the industry itself to determine if they were putting investors at risk. We don't allow drivers to self-regulate speed limits, but.......

The whole process worked as long as everyone believed housing prices would go up and the economy would grow forever; that they would always have jobs with high pay; that people believed they were entitled to nothing but the best, NOW.

This is perceptual economics, one principle of which is that any widely held belief in the market tends to become a self-fulfilling prophecy. In the case of housing, homeowners took on ever-larger mortgages in the belief that prices would keep rising. In the case of debt - credit card or other - I don't know what the hell people were thinking....that there was always UI and welfare???

Lenders now claim they thought the loans were safe because even if a homeowner defaulted, the mortgage holder would be left with a house that was increasing in value. And what they don't admit is that it was easy for the banks to lend someone else's money. I remember the days when the only people they would loans were those who didn't need them - because banks knew it was their depositor's money and their responsibility to use caution - due diligence.

Once they came up with these little schemes, nobody on the inside cared about anything. In Canada, the banks could not lose, no matter what. If they did take a write down, it was a cost of doing business, and now - thanks to the accountants - they can make up an imaginary number even for that. Plus they can pawn their worthless paper to the Bank of Canada for real money. Of course - that creates all kinds of problems down the road, but what the hell, let'er roll.

Either these people were such nutjobs that their confidence in rising prices led the creators and purchasers of mortgage-backed securities to think these investments were virtually risk-free - including the over-leveraged -- as long as there was easy credit and quick returns, and investors clamoured for more. And this applied to money market funds that brought the paper from structured investment vehicles.

As long as the money market funds had confidence in the system, they didn't cash out when their investments matured, they rolled them over at the same interest rates. This allowed the SIVs to mint money without posting liabilities.

They were either out of their minds - or they were shysters - either/or/both? Now they are being painted as deluded innocents. And the government/s have had to step in to cover the butts of these confirmed free-enterprisers - to restore faith in either the crookedest or stupidest group of people to every come down the pike.

But for most of us outside the club - well too bad so sad - no pension, higher taxes, inflation, job loss, devalued dollar, resources dropping like a stone, investments evaporating, governments doing what they always do - the wrong things, and the finance people - well they were handed a ton of money to play with and are back to their old tricks - helped by "improved" accounting standards - good golly Miss Molly!

This system kept the U.S./Canadian economy chugging along for 35 years; of course, real wages have been stagnant, but house values skyrocketed, so many homeowners refinanced and cashed out equity -- turning their homes into ATMs -- they used the money to pay credit card debts and car loan debt and to consume.

If you owed $200,000 on a mortgage, but the house rose in value to $300,000, you could turn the $100,000 difference (or a portion of it) into cash by refinancing (at rates that ultimately would break the back of a camel - but who cares?).

By 2004, Americans were using home equity to finance as much $310 billion a year in personal consumption. This debt-driven consumption was the engine of growth. And this is the engine all the government interventions in the economy are trying to re-start there and here???

Over-consumption here was balanced by over-production in many poorer countries like China, India, Taiwan and South Korea - they now have large trade surpluses with the West, which is speeding their economic development - but they invested in our junk paper. That way they get much less for what they produce - if/when they figure that out, and pull their money, or ask for gold or other assets, where will we be - with our de-valued dollars?

It's what some economists call a virtuous cycle: we buy their goods, helping them develop, while they use the profits to buy our credit, allowing us to purchase more of their goods. But it's also unsustainable. We cannot over-consume forever.

In the final stage of the housing bubble, fewer buyers could afford traditional mortgages. Rising house prices required ever-larger down payments so all kinds of "strategies were brought to bear - because everyone has a right to decent housing. They do - but mansions?

Mortgages multiplied, and often required little or no money down and ran for 40 years. From 2004 to 2006, nearly 20 percent of all mortgage loans were "subprime" in the US; Canadians simply overpaid. A vast supply of adjustable-rate mortgages (ARMs) created a time bomb. The minute interest rates went up, the mortgage rates reset, and homeowners with ARMs were saddled with larger monthly payments. Even 5-10 years in, there would be trouble, and with everything else that was going on (job loss, other ballooning debt, etc), people should have known better.

Various factors combined and continue to lower real-estate and stock prices and to deflate the bubbles. Oversupply of houses in the wrong places, ever-accelerating prices/indexes (and P-E ratios) meant smaller returns and, again, government interventions were either stupid or ethically wrong- headed.

Once the bubbles started to leak in the US, Canada started plugging the holes until the election was over, telling us that US problems (even though they are our largest customers across the board) and was looking at mania turning into panic, would leave us high and dry. Pas de Sweat!

It was a lie, but people wanted desperately to believe it. In just days the dollar and the resource sector have tanked, plus the TSX looks like it's having a nervous breakdown. Some steps taken by our government and its henchmen to ward off the inevitable border on the criminal.

In the US, first, structured debt instruments like collateralized debt obligations and mortgage-backed securities failed. Securitization spread across the entire financial system -- putting everyone at risk. Because the finance sector had lobbied aggressively for decades to slash regulation, lack of oversight magnified the problem.

ABCP froze over a year ago and now the whole system could go belly-up. Recession, depression, stag-flation, government intervention, a failure in confidence - every body calls it anything but what it was - at best total systemic corruption; at worse widespread criminality.

As panic is setting in, asset backed commercial paper -- is locked in for a decade -- except for less than $2 of over $32 billion paid to individuals and a few side deals cuts with key players.

In Canada, some of the agencies hit have turned right around and are selling their own commercial paper; banks don't have to accurately reflect it on their financials; and the central bank, in addition to flooding the market with cash, has to buy this trash for cash on demand. Those responsible have been indemnified.

While the US was in a liquidation trap, our banks and government were tap dancing until the election was out of the way. Nobody even knows the true size of the losses, because of the leveraging, and banks began to hoard funds which caused credit markets to dry up. That was seen as bad - I'm not so sure it was. Some pain now or a lot more later - your call.

Over the last year, the U.S. has taken increasingly drastic measures -- lowering interest rates, pumping cash into the banking sector, allowing investment banks to borrow funds while putting up low-valued securities as collateral. This evolved to financing takeovers, then to nationalization; followed by the federal takeover of AIG. Wall Street banks disappeared in a fortnight -- bankrupt -- acquired or converted into bank holding companies. But the contagion has not been contained. Whether the bailout plan can succeed is questionable. It can only do so depending on just how dumb people are.

Can government bailouts "restore confidence" in a corrupt system in which the players don't even trust one another enough to thaw the frozen money and credit markets? Even if the bailouts revive the banking sector in the US and Canadian Banks can still play innocent, few economists think state intervention will jumpstart the consumer credit machine. It never has in the past.

Over-leveraged, money-strapped banks will eagerly dump worthless securities on taxpayers in exchange for cash to bulk up their reserves - you bet! Plus, with working hours and wages declining and unemployment increasing in "real" jobs, home foreclosures and inflation surging, banks are in no mood to give consumers credit, so consumption -- and hence the economy -- will continue to contract. Call me hard-hearted, but I think people have enough debt already.

There are better options: avoiding the poisonous corporate paper (some isn't - by the way); the state can buy equity stakes directly in troubled banks and near banks, re-regulate the industry, send in teams of government (not contract) auditors to decide the real worth of financial companies - which should live and which should die; allow the government to buy troubled mortgages directly, allow local governments to seize foreclosed homes and turn them into subsidized housing, public works programs, alternative energy investments.

But these are political strategies and they depend on an ethical government organizing political power to propose, legislate, fund and enact sensible strategies, and not run around under the radar covering the backs of their friends, thereby perpetuating the cycle of corruption and irresponsibility that landed us here in the first place.

That's what will determine if there is a 21st-century New Deal or if Wall Street/Bay Street will get away with the biggest financial crime in world history. Most people are clueless - led astray by masterful mass advertising campaigns and our political leaders.

============
This article relied on many sources, including "The Subprime Debacle" by Karl Beitel, Monthly Review, May 2008. This essay was printed in the Oct. 3, 2008, issue of The Indypendent, and the November 2008 issue of Z Magazine. I also took my crack at it to try to make it relevant and to show that as goes the US, so goes Canada to a greater degree than we have so far been told.
Arun Gupta is an editor of the Indypendent. He's writing a book about the decline of American Empire to be published by Haymarket Books.

While predatory lending practices were not as prevalent in Canada as they seem to be in the US, we were the recipient of many of the marshmallow backed investments up here. How did they get in and how did they get past our fantastic self regulatory system:)

First, knowing that these investments had no proper credit rating to meet our Securities laws, three or more of out top five banks did what any upstanding business would do. They applied for permission to break our securities laws (legal exemptive relief) with one of the self regulators. Since the heads of our thirteen provincial and territorial Securities Commissions are often hired directly from the investment industry, or from service providers to the investment industry, they always get approval. And they always have a host of perfectly good reasons why it will be in the public interest to grant permissions to break the law...........Not!
No public notice is given. No public input is allowed. It is a strictly behind closed doors arrangement between regulators and the industry. Public be damned. Now I know why each of our 13 seurites commissions are paid more than $500,000 at the top, and paid by the investment industry. It helps smooth the way to these permission slips.

There are thousands of such exemptions on the books in Canada, and not one of the securities commissions will answer in what public interest they may be.

So we have predatory selling practices in Canada, if not predatory lending practices. We have products and advice that do not meet our laws, dressed up like lipstick on a pig, using permission slips to break our laws, granted by a severely incestuous relationship between our regulators and the industry.

And this is how Marshmallow Backed Investments found their way into Canadian Accounts. It is also partially the reason for many other predatory or public abusive investment schemes that have occured in Canada.

It is hoped that open public inquiry will be held soon to reveal these tricks of the trade to the public. Unfortunately, the industry is still in firm control of the public relations in our country and thus of the public opinion. Conventional media pretty much toes the line that comes from the financial industry, while current politicians don't even know what they don't know on this matter. But it is changing............

A skeleton friendly to small investors
September 22, 2008 Toronto Globe And Mail

The turmoil in the world's financial markets reached Canada's final court of appeal on Friday, by way of the asset-backed-commercial-paper restructuring. The case illustrates how the law is sometimes called upon to improvise, when there are gaping holes in a regulatory framework.

The Supreme Court of Canada, largely concerned in the past quarter-century with Charter litigation, showed consideration here for the investors and the commerce of this country, by hearing quickly a leave-to-appeal application, and also by not prolonging matters. The court decided not to hear an appeal.

Though Canada has not suffered directly from the collapse of the subprime-mortgage market in the United States, modest investors lost access to some or all of their life savings, because of a regulatory regime based on the mistaken assumption that ABCP and similar interests would be bought only by the most sophisticated investors.

An ordinary prospectus requirement - not any novel form of regulatory intervention by the state - should have applied to ABCP, or at the very least an offering memorandum, to clearly inform purchasers what they might be getting into. But investment advisers, some of them not very sophisticated themselves, were marketing these interests as if they were straightforward, not the elaborate chains of assets and liabilities that they are.

After the ABCP market seized up, a strange creature was deployed. The Companies' Creditors Arrangement Act is a federal statute from the Great Depression, which had once seemed obsolete, but ingenious lawyers in the 1980s found a new and artificial way - "instant" trust deeds - in which it could be used in unwieldy restructurings of large insolvent corporations, when bankruptcy proceedings were thought to be too rigid.

The ABCP reorganization by way of the CCAA is a salient example of the highly flexible use of what the Ontario Court of Appeal called the statute's "skeletal" nature, as if flesh can be added on at the discretion of fair-minded judges.

Here, the mind-boggling fleshing out of the CCAA's bare bones includes requiring creditors to give releases to companies that were not insolvent themselves - that is, other than the "debtor company," itself a set of entities ("master asset vehicles") brought into being just so as to fit the whole mess into the CCAA.

Though the Middle Ages have been accused of a propensity for legal fictions, our own times are quite creative in this respect, too.

This is not the best way of doing things, but the dissenters against the ABCP plan have had their days in court at three levels of the judiciary, and judges at all these levels have found the restructuring plan to be "fair and reasonable."

For the future, though, securities legislation should provide investors with more transparency.

Ripples from the latest turmoil in the U. S. financial markets are threatening to create more trouble for the proposed restructuring of $32-billion of asset-backed commercial paper that has been frozen for more than a year in Canada.

The Supreme Court of Canada is expected approve the massive workout in the next few weeks, clearing the way for the seized-up ABCP to be converted to long-term notes.

But because of the implosions on Wall Street and the damage that has done to credit markets, the restructured notes will likely be just as illiquid as the old ones, observers say.

"The events of the last few days in the U. S. have clouded even more the value of the underlying assets [of the notes]," said Laurence Booth, a professor of finance at the Rotman School of Management at the University of Toronto.

"Basically there's $32-billion of ABCP, but the market value of those [notes] is still not going to be anywhere close to $32-billion,.

Because of the complexity of the credit derivatives underlying the paper, potential buyers will have limited ability to put a value on the notes. The problem is compounded by the mess in credit markets, where investors are choosing to flee instead of even attempting to make bids, Mr. Booth said.

The credit crunch was sparked by the failed sub-prime mortgage sector in the United States, spreading into other areas such as asset-backed commercial paper and structured investment vehicles as investors were hit by huge losses.

In the wake of the failure of chief executive Richard Fuld's Lehman Brothers Holdings Inc. and the troubles at American International Group Inc., focus has shifted to credit default swaps, a massive global market estimated at about US$62-trillion.

Credit default swaps are basically insurance policies on bonds. The buyer of the protection pays a regular stream of premiums to a counterparty -- typically a big bank or insurance company -- in exchange for a promise to cover losses in the event of a default. Over the past few days, the market has been facing a particularly difficult time, with spreads blowing out to record levels as buyers run for the exits.

That is a big problem for ABCP holders because the bulk of the underlying assets are CDSs linked to pools of corporate debt. Observers say that despite the mess on Wall Street the CDSs have not been hit by major losses, but the market for such products has still disappeared.

"There is absolutely no demand for that sort of stuff," said one analyst. "We're seeing people would just rather stay away."

When the restructuring finally goes ahead, "there won't be a market for the new notes. It will be just a few hedge funds who might buy it," he said.

A lawyer for the investor committee overseeing the restructuring disagreed. "It is everybody's opinion that there will always be a market but the pricing may be a question," said Francesca Guolo, a partner at Goodmans LLP. "Where the market will be when the restructuring closes two to four weeks away is incredibly difficult to predict.... But we are hopeful."

The restructured ABCP will "likely be one of the most complicated structured credit product ever released into the market," said Colin Kilgour, an industry expert.

correction to the previous post. I recall now that the Quebec Securities Commission announced a wekk or two back that they were going to look into the ABCP issue.

This poses an interesting situation since Quebec is the province which is showing true grit at dealing with financial fraudsters. It may cause the other dirty dozen provincial and territorial commissions to appear somewhat useless in comparison..........or it may be a cause for Quebec to "be a team player", and look the other way in solidarity with the rest.

As I was driving home this afternoon, I was thinking of exactly what it was that was the biggest message of the whole affair. I came to this conclusion.

1. Despite the fact that the USA had gotten authorities involved and ordered over $50 bil in fines and repayments of customer losses..............within six months of the failures.
2. Despite the fact that there are over 100 offices, agents, departments, ombudsmen, others (like the ASC) purporting to protect the investing public in Canada...........
3. Despite this being the largest financial liquidation (melt down according to some) in North American history......

Despite any and all public relations and marketing to the contrary, I can find no evidence of any person in a position of authority (ASC, OSC, IDA, RCMP) or any government protective agency in Canada even taking a stance, or a look at this crisis. In fact, I have evidence to the contrary, that those in positions of authority have actually aided and abetted the pilaging of public investment accounts.

Similarly, at the City of Leth, (my town is stuck with $30 mil) I see no evidence of a person or persons, standing up and speaking on behalf of the public whose money this is.

I see only a private "cleanup crew" headed by a former tobacco industry lawyer who led the company into the smuggling business. This person and his private, non-sanctioned cleanup crew is the sum total of the entire Canadian effort during our largest crisis.

It almost speaks volumes louder than words can convey to the topic of Canada being lawless financially. Or as former Bank of Canada governor David Dodge was quoted as saying, "Canada has a reputation internationally as being a Wild West".

Friday, April 18, 2008
Portfolio Complexity: The toxic cake!
Wow, do you ever wonder how an industry with so many smart people can get itself into such a huge mess? Having met Purdy Crawford, I know he is extremely bright and experienced and a great choice to sort out the ABCP issues in Canada. So is it not amazing when he takes months working with a hand picked selection of bright minds, and then acknowledges they have no idea what the ABCP is worth today! I guess that qualifies as complex!

Asset Backed Commercial Paper is one of the best examples of smart people outwitting themselves. It all starts with simple assets like a mortgage, but a straight mortgage can only generate so much profit for the smart folks. So from the mortgage comes mortgage backed securities, then comes a complex bundling process that is like baking a cake. When the recipe is right, the individual ingredients cannot be easily distinguished but the finished product looks and smells great! Unfortunately, as with baking, a little of the toxic stuff can be mixed into the investment bundle and perhaps not be fatal. Maybe we use a few ingredients that are past there "best before dates", who will know or care, right. Well, in a great kitchen the chef would notice and of course in the investing world the rating agencies would know. Quick comment: trust your chef before your rating agency, the chef is not paid by the flour mill!

Not surprisingly, it would appear that there is a limit to how much of the ingredients can be toxic before the cake is poisonous. And to bring this long analogy to an end; the cakes have all been baked, nobody knows how much of the ingredients are toxic, and there are very few investors lined up to sample the outcome! The smart guys in the kitchen can't tell the good cakes from the bad and it would appear the bakeries sold enough cake to feed the world!

So what have we learned: The old adage still holds true....you can't have your cake and eat it too!

As for complexity in your portfolio....beware the advisor selling baked goods! Check the ingredients before you scoop up the icing! For a more rational and clear understanding of portfolio complexity, check out the 3rd issue of the Second Opinion Newsletter .

Today we are going to talk about how the challenges of today will inspire the financial wizkids of tomorrow! Most recently we have felt the impact of the "skill" or perhaps more appropriately, the "cunning" of financial engineering. The increase in "structured" solutions has come at a tremendous cost as we have all seen with the Sub Prime situation and ABCP fiasco.

While rationale minds might think that would lead to the sale of more "vanilla" securities like stocks and bonds and Index funds, that is not likely to happen any time soon. Financial engineering is "industry speak" for hiding the fees behind the concept. So whats coming next.....

What will actually happen is that the financial "engineers" will construct more of the same structured stuff that got us into trouble today! If real engineers and construction firms worked the same way as financial engineers, houses would be falling down all around us as I write. But one needs to assume we are not crazy enough to buy the same risky securities as the ABCP and bad mortgage products we bought; so this time around the engineers will have a whole new approach to the products. Look for the word "GUARANTEED" to become prevalent in the sale of the "new" structured products! Having just been burned they know we are all looking for a "sure thing" before we dip our investing toe back into the shark tank.

How will they manage this engineering feat? Think of a rundown dilapidated house, but with a new coat of paint and new vinyl siding! The risks and future repairs are hidden by the cheap covering to provide a sense of quality that is not there.

Securities are actually quite basic. They are investments upon which you earn a rate of return determined by rent and risk.
Rent is the return you could get from a zero risk investment such as a short term government guaranteed treasury bill. That is known as the "risk free rate of return".
The "risk" portion is the additional return you get for accepting volatility and some amount of uncertainty in your return. As an example with bonds that risk portion would be the credit risk of the issuer and the impact of interest rate changes on the bond value.

So, if somebody is offering you returns above the risk free rate, and suggesting you have a guarantee, then where did the risk end up? The return over and above the T-Bill rate means there is risk, but the guarantee means somebody else is taking the risk for you! Sounds great! So, just one question(?) what are they getting in return?

Well, for the most part they are getting a significant chunk of the return you might think you will be getting! The neat thing, for the engineers, is you are the only one putting money into the proposition! They are taking a per cent of your positive returns and none of the negative returns because the guarantee is paid for from your deposit. Perhaps now you can see where the cunning comes into the equation!Perhaps these products need to come with a warning on the label:

While that is never likely to happen, the real disgrace is that these products will be sold to those seeking the least risk and who can often least afford the costs.

So what should you be watching for:

Guarantees: Unless you are buying a bank GIC with CDIC coverage or a short term Government Bond, do NOT ever trust a guarantee.

GaffleGab: If you do not understand a product, do NOT think it is because you are stupid. There is a great chance the confusion is intentional and a pretty good chance your advisor does not really understand it either.

Fees: Structured products are often designed to hide fees. Ask for a clear description of all fees in writing from your advisor along with comparable fees without the guarantee. In fact ask your advisor why they can not create the same product for you from standard easy to understand securities.

The attached leads to a great Ken Hawkins article on structured products for those wanting to learn more!

I am 90% convinced that a case for fraudulent misrepresentaion might be made against those who used a "salesperson" licence and who misled customers into thinking they were "advisors" and sold them this tainted investment product.

Tainted product or not, this flogg has for years been trying to seek clarity on the fundamental question of whether canadians are dealing with salespersons or with trusted financial advisors.

I suspect the ABCP crisis might be the trigger that puts the question to the forefront of the nation. Whether I am right or not, I would like to see the question answered with clarity and transparency for the benefit of everyone.

If my hunch is correct, a win in the legal arena might not be assured, but an open discussion might lead to a moral victory or a court of public opinion victory. After all, it is pretty hard to beat the men with the money in a legal sense, they write the laws in our beloved financial services industry. But I have no worries that if morals, and ethics were to be taken into account, that some of their codes of conduct and behaviors would not pass a smell test.

The article is posted on the Complinet Group website. Founded in 1997, Complinet Group is a provider of risk and compliance solutions to the global financial services community. Complinet's website says its customers include 80 per cent of the leading financial services firms across the globe.

"Canadian banks brag that they have fared much better than their American and international counterparts, who have collectively taken close to $500bn of write-offs for US subprime mortgages and structured credit vehicles. In the rest of the world, the banks were forced to honor their international style liquidity agreements and to take back the asset backed commercial paper onto their own balance sheets.

These banks often voluntarily bought back other distressed debt from their customers where they had no legal obligation to do so in an effort to protect their reputations. The American and international banks took billions of write-offs for the bad underlying assets and credit default swap contract losses within the ABCP they sold, whereas the Canadian banks and their wholly owned securities dealers have been given immunity from civil lawsuits for remedy of their customers' damages in the Canadian ABCP bankruptcy protection plan.

Canadian banks have been given a gift of unfair competition versus the American and international banks, at the expense of Canadian governments, pension funds, corporations and individuals who own more than $1m of the distressed Canadian non bank ABCP."

"The Canadian federal and provincial governments failed to protect the retail owners of non bank ABCP by approving a series of banking, securities and bankruptcy law and regulation amendments since 2004 that facilitated the manufacture and sale of the non bank ABCP in a negligent and potentially fraudulent manner, and then gave clear advantage to the banks in the bankruptcy restructuring process itself.

With glaring contrast to Canada and an illustration of how governments can intervene to protect its citizens from flawed savings products, a twelve US state and federal government consortium has to date ordered the repurchase of $55bn of auction rate securities from retail, charitable organizations and small corporations by eight securities dealers. There are a total of 40 securities dealers expected to receive auction rate securities repurchase orders from this US governments' consortium, including the Royal Bank of Canada.

Many Canadian banks, securities dealers and other financial institutions have made voluntary repurchases of close to $5bn of the non bank ABCP from their retail customers. In an August 19, 2008, teleconference call, Purdy Crawford describes the retail customers of these banks as "damn lucky." The well-publicized Canaccord and Credential Securities' under $1m customer relief plans provides for $177m cash settlement at the face amount plus accrued interest and legal costs to their applicable customers. But, the 1,800 Canaccord and Credential Securities retail owners will not get their cash back until the Supreme Court of Canada approves the ABCP CCAA restructuring plan and this is not a certain outcome.

Many retail non bank ABCP owners with over $1m of non bank ABCP have no cash settlement offer at all or have offers that are clearly deficient for the $100m of non bank ABCP they own. National Bank Financial has not made all of its retail customers whole. Every individual, family trust and personal investment holding company owning non bank ABCP should receive a cash settlement at the full face amount of ABCP owned."

For the second time this summer, the Supreme Court of Canada may decide the fate of investors with billions of dollars at stake, after an opponent of the $32-billion asset-backed commercial paper restructuring announced plans to pursue the challenge to the highest court in the land.

Ivanhoe Mines Ltd., which is stuck with $70.7-million (U.S.) of ABCP because of last summer's freeze-up in the market for the short-term investments, is asking the court to stop the planned restructuring.

Ivanhoe is arguing that the restructuring is unfair because it gives all participants in the ABCP market broad immunity from lawsuits, and that the Ontario Court of Appeal ruling on Monday allowing the proposal to go ahead is flawed, said Howard Shapray, Ivanhoe's lawyer.

Purdy Crawford, head of the investor committee that created the proposal, said yesterday that the aim is still to try to complete the restructuring by Sept. 30. The plan calls for swapping the frozen notes for new bonds that trade freely.

Some of these protective agencies similarly allowed exemptions to our laws to allow salespersons to disguise themselves as qualified professional investment advisors (which requires a license they did not have) in order to better market this tainted product.

If I look up the definition of fraud in our criminal code some of these tricks come pretty close to fitting the definition. I wonder if the RCMP has the time to look this up.

We now see a restructuring of the debt in which protection is being granted against lawsuits in return for some of these poor people getting their own money back. Isn't that a bit like blackmail to withold a client's money from them unless and until they agree not to sue?

Compound this with the restructuring having been negotiated by a man who led a tobacco company to this press release:

The RCMP made the following announcement today, July 31, 2008, concerning admission of guilt by Imperial Tobacco on illegal tobacco smuggling during 1989-1994. Purdy Crawford was the CEO of Imasco during 1985-1995, which covers the 1989-1994 time period when Imperial Tobacco, a wholly owned subsidiary of Imasco, conducted the illegal activity of tobacco smuggling for the purpose of avoiding the payment of Canadian tobacco taxes. Purdy Crawford is now employed at Oslers LLP and he is the Chairperson of the Pan Canadian Committee, who are the applicants for the ABCP CCAA Restructuring Plan, being administered at the Ontario Superior Court of Justice.

When I set out on this journey, I fully expected to find corruption and greed wthin the financial industry. What I did not expect, and what truly shocks me the most, is the extent which the legal and regulatory industry can be captured or purchased using this same greed and corruption.

Last edited by admin on Tue Aug 19, 2008 6:15 pm, edited 1 time in total.

NEW YORK -- In the U.S. mortgage industry, they are called "liar loans" -- mortgages approved without requiring proof of the borrower's income or assets.

The worst of them earn the nickname "NINJA loans," short for "no income, no job, and (no) assets."

The struggling U.S. housing market, already awash in subprime foreclosures, is hit with a second wave of losses as homeowners with liar loans default in record numbers. In some parts of the country, the loans threaten to drag out the mortgage crisis for another two years.

"Those loans are going to perform very badly," said Thomas Lawler, a Virginia housing economist. "They're heavily concentrated in states where home prices are plummeting," including California, Florida, Nevada and Arizona.

Many homeowners with liar loans are stuck. They can't refinance because housing prices in those markets have nose-dived, and lenders now demand full documentation of income and assets.

Losses on liar loans could total US$100 billion, according to Moody's Economy.com. That's on top of the US$400 billion in expected losses from subprime loans.

Fannie Mae and Freddie Mac, the largest buyers and backers of mortgages in the United States, lost a combined US$3.1 billion between April and June. Half of their credit losses came from sour liar loans, which are officially called Alternative-A loans (Alt-A for short) because they are seen as a step below A-credit, or prime, borrowers.

Many of the lenders that specialized in such loans are now defunct -- banks including American Home Mortgage, Bear Stearns and IndyMac Bank. More lenders may follow.

"Everybody drank the Kool-Aid," said David Zugheri, co-founder of Texas-based lender First Houston Mortgage.

Liar loans were commonly paired with "interest only" features that allowed borrowers to pay just the interest on the debt and none of the principal for the first few years.

Even riskier were "pick-a-payment" or option ARM loans -- adjustable-rate mortgages that gave borrowers the choice to defer some of their interest payments and add them to the principal.

Now that prices have fallen, almost 13 per cent of borrowers with liar loans were at least two months behind on their payments in May, nearly four times higher than a year earlier, according to First American CoreLogic.

Countrywide Financial Corp., now part of Bank of America Corp., was one of the top providers of liar loans. More than 12 per cent of Countrywide's US$25.4 billion in pick-a-payment loans are in default, and 83 per cent had little or no documentation, according to a Securities and Exchange Commission filing last week.

Critics say Fannie Mae and Freddie Mac, which bought or guaranteed liar loans from lenders including Countrywide and IndyMac, should have stuck with traditional 30-year, fixed-rate mortgages.

"I personally think that they ventured beyond their mission," said Richard Smith, a Tennessee mortgage broker.